Economics Basics: a review

Transcription

1 Economics Basics: a review FRST 318/537c - Forest and Conservation Economics January, 2015

2 Economics review Warning: the following slides are necessary but, admittedly, quite boring.

3 Outline Demand, Supply & Market Equilibrium Assessing Change in Welfare (The importance of) elasticities

4 Lab structure This is likely the only PowerPoint presentation! Usually: Go over concepts that may have been unclear in the lecture and hand back quizzes Answer any questions you may have Complete problem sets & work on case studies

5 Course website Class lectures Problem sets Readings (or links to readings) Syllabus and detailed course outline

6 Cost Concepts What is a supply curve? Types of costs Fixed Costs Variable Costs The importance of marginal costs versus average costs

7 Types of Costs Fixed Costs Production expense that does not vary with output Examples? Variable costs Production expense that does change with output Examples?

8 Fixed Cost, Variable Cost, and Total Cost $ Total Cost Variable Cost Fixed Costs Output

9 Algebra of Costs TC=FC + TVC And ATC=AFC + AVC Where: TC = Total Cost FC = Fixed Cost TVC = Total Variable Cost and ATC=TC/Q and so forth.

10 Costs ($) Total Cost Fixed Costs Output $/Q Average Total Costs Average Variable Costs Average Fixed Costs Output

11 Marginal Costs Marginal cost (MC) = Change in Total Costs/Change in outputs MC = ΔTC/ΔQ Since fixed costs remain the same, it is the change in total variable costs that marginal cost measures It is also the case that the marginal cost curve represents the slope of the cost curve

12 Costs ($) Total Cost Fixed Costs Output $/Q Marginal Costs Average Total Costs Average Variable Costs Average Fixed Costs Output

13 Returning to the Supply Curve It turns out that the the supply curve is the marginal cost curve for each firm: S = MC

14 Demand Curves P Source: olumn/07/joey-chestnut-winsnathans-famous-hot-dog-eatingcontest-by-eating calories/ Q

15 Also a measure of value P Diminishing Utility MB (D) Total Benefit Q Source: olumn/07/joey-chestnut-winsnathans-famous-hot-dog-eatingcontest-by-eating calories/

16 Also a measure of value P D P* Q* Q

17 First Fundamental Assumption Firms are interested in profit-maximizing Given that profits = Total Revenues Total Costs, or π = TR-TC, the highest level of profit is found where the difference between these two is the greatest (so not necessarily where TR is highest, or TC lowest) Firms find this point by examining what the contribution to profit (if any) is from producing another unit of output

18 Second Fundamental Assumption Perfect Competition This means that all firms are price-takers (they have no influence on the price) They see perfectly flat (infinitely elastic) demand curves (although overall market demand curve is downward sloping) When the demand curve is flat Marginal Revenue is constant and equals Price. Therefore firms will price at marginal cost, or choose their production level (Q*) such that MC(Q*)=P

19 Profit-Maximizing Rule This is equivalent to setting Marginal Revenue equal to Marginal Cost, or MR=MC In other words, will you get more for that additional unit than it costs? If MR>MC, then you are making a profit on it and should expand If however MR<MC, then you are losing money-and producing too much Under assumption of perfect competition, P=MR then P=MC

20 $ Total Revenue Total Cost Fixed Costs Output (Q) $/Q Marginal Costs Marginal Revenue Output (Q)

21 $ Total Revenue Total Cost Fixed Costs Output (Q) $/Q Marginal Costs Marginal Revenue Output (Q)

22 $ Total Revenue Total Cost Fixed Costs Output (Q) $/Q Marginal Costs Marginal Revenue Output (Q)

23 Profit-Maximizing Rule MR = MC

24 Firm equilibrium in perfect competition p* P MC ATC q* Q P p 1 MC ATC P MC ATC p 2 q 1 Q q 2 Q Examples of disequilibrium (in perfect competition) (positive profits or losses)

25 Market Demandsummation of individual demands Mill A Mill B Log Market Demand D 1 D 2 D ,000

26 Market Equilibrium Economics Review

27 +200, , , ,000 Price ($/m3) Demand (m3/month) Supply (m3/month) Surplus Price Effect , , , , , , , ,000 0 none ,000 80, , ,000 20, ,000

28 Market Equilibrium maximizing social welfare* (lots of assumptions) P S p* D q* Q

29 Why is social welfare maximized? Marginal revenue product = marginal factor cost Marginal social benefit = marginal social cost Value of the marginal product = marginal revenue product MSB=VMP=MR P=MFC=VMF=MSC

30 Assumptions required for markets to yield social optimum Firms and consumers are rational maximizers Efficient property rights Perfect competition Free entry Perfect information Mobile labour and capital No externalities All inputs and outputs are priced Satisfactory income distribution

31 Market Adjustments Everybody knows umbrellas cost more in the rain -Tom Waits, Bad As Me (2011)

32 Demand and Supply Shifters Demand Change in size of market Number of buyers (certified wood) Population Change in tastes Change in price of other goods complementary substitutes Change in income Change in needsumbrellas in the rain Supply Change in price of inputs Changes in available technologies Profitability of other goods Catastrophic events Earthquake, Tsunami Policy changes MPB AAC uplift BUT NOT a change in the price of the good

33 Shifts in Demand for Lumber s $ $500/mbf D Housing Starts 2004 $200/mbf D 1 Housing Starts 2008 Housing Starts

34 P D S P D D n S P D n S S lr p* p p Q Q Q Market equilibrium after an increase in demand P MC ATC P p* MC ATC P MC ATC p Q Q Q Firm equilibrium after an increase in demand

35 Long Run versus Short Run P D Long-run supply b S S 1 In the short run, an increase in demand from D to D1 causes an increase in price (move from a to b) S l as you move up along the existing supply curve; c In the longer run, suppliers adjust (new ones a D 1 may enter, new technology may be used) and there is a new supply curve (S1); price then falls (b to c); As demand changes, then a and c trace out the long Run supply curve (imagine the process repeating itself) Q

36 Demand Elasticity Economics Review Elasticity refers to the relative changes in demand quantities for a given change in price Elastic means that there is a big change in quantity for a little change in price Inelastic is the opposite-price changes substantially but there is little change in quantity It is important because it tells how the market will react to a change in policy, and how costly that change might be

37 Elastic and Inelastic Demand Curves % change quantity demanded in response to % change in price Under 1 is inelastic Over 1 is elastic 1 is unit-elastic (10% change in price would lead to a 10% change in quantity demands) * The same concept applies to Supply curves

38 Price Elasticity Ep = % Change in Quantity % Change in Price Ep = Q P P * (arc elasticity) Q Ep = dq dp * P Q (point elasticity)

39 Why is it important to know elasticity? Economics Review

40 Additional Supply Curve: Economies of Scale 1. Long run concept: Reductions in unit cost as the size of a facility and the usage levels of other inputs increase A producer s average cost per unit to falls as the scale of output is increased 2. Economies of scale is a practical concept that explains real world phenomena Think "too big to fail" In some industries (notably forestry and mining) companies grow to be very large